Washington -- A series of class-action lawsuits is focusing new attention on two issues that often leave home mortgage borrowers in the dark:
What rights do consumers have to cancel private mortgage insurance coverage once their equity stake in the house has risen to 20 percent or more?
And what obligations do lenders or mortgage insurers have to inform consumers of their cancellation rights -- either at loan closing or in subsequent years?
Trial attorneys in several states have begun filing class-action suits against banks and mortgage companies that routinely allow their borrowers to keep on paying mortgage insurance premiums every month, no matter how large their equity cushions may be, and no matter how remote the risk of loss from foreclosure may have become.
Private mortgage insurance is designed to provide lenders -- or the ultimate purchaser of a lender's loans, like Fannie Mae or Freddie Mac -- protection against financial loss in the event of a borrower's nonpayment. The term "private" distinguishes it from insurance or guarantees provided by governmental underwriters like the Federal Housing Administration. Fannie Mae and Freddie Mac both require private mortgage insurance coverage on all loans where borrowers put down less than a 20 percent down payment. Many private lenders who retain or sell their mortgages to other investors have similar requirements.
Should a homeowner default on monthly payments and go to foreclosure, the insurance would pay the lender's or investor's costs to some pre-specified coverage level. The fees for such protection typically are paid directly by the borrower. A 10 percent down payment, $200,000 loan with monthly premiums might cost the consumer $936 a year or $78 a month initially, according to a spokesman for MGIC, a major private insurer. A 5 percent down, $100,000 loan with similar coverage would cost $741 the first year. Mortgage insurance premiums decline gradually over the term of the loan, as the principal amount of the mortgage outstanding declines.
Since the risk of loss to the lender diminishes as the borrower's equity stake grows beyond the 20 percent level, large investors like Fannie Mae or Freddie Mac permit cancellation of insurance coverage under certain circumstances. Freddie Mac, for instance, allows cancellation upon written request of some owner-occupant borrowers with 20 percent or higher equity stakes and excellent payment histories. Other conditions may apply as well: A minimum of two years must have elapsed from the closing date of the loan, and a current market appraisal -- at the borrower's expense -- may be required.
The new class-action suits over insurance cancellation charge that lenders and mortgage insurers deliberately collect huge amounts of premium dollars from consumers long after the need for insurance has passed. Charles S. Zimmerman, a Minneapolis-based attorney whose firm, Zimmerman Reed, has filed half a dozen suits against lenders recently, put it this way:
When a homeowner's equity stake is 30-40 percent of the market value of the house, "where is the risk? By not informing borrowers about the right to cancel, lenders and PMI [private mortgage insurance] companies are collecting large premiums for risks that no longer exist."
In one pending case, Zimmerman's firm has sued Twin City Federal Mortgage Corp. and MGIC, alleging that they "actively conceal" borrowers' rights of cancellation, and the criteria for qualifying for cancellation.
The suit also charges that Twin City Federal Mortgage receives "commissions or servicer fees" for selling, processing and forwarding premiums to MGIC -- thereby "unjustly enriching" both defendants.
Representatives of both Twin City Federal Mortgage and MGIC vigorously deny the suit's allegations. Twin City vice chairman Robert Evans says the mortgage that triggered the suit is owned and serviced by his firm and carries insurance cancelable solely at the request of his firm.
"The [mortgage insurance] contract says insurance will be maintained for the life of the loan," Evans said. "There is no language about any specific loan-to-value" permitting cancellation. Evans also denied that his firm receives any upfront or periodic compensations from MGIC for maintaining insurance coverage.
A spokesman for MGIC emphasized that a mortgage insurer's role is straightforward regarding cancellation: "If a lender or investor tells us to cancel [a policy], we cancel. Won't ask whether the loan-to-value ratio is 95 percent or 75 percent or whatever. It's totally up to the the lender or investor."
The current wave of class-action suits is likely to shine new light on the process, and could have wide-ranging effects on homeowners nationwide.
In the meantime, here's some practical advice for homebuyers, refinancers and owners whose loans currently carry mortgage insurance:
* Only a handful of states require meaningful disclosure of mortgage insurance procedures and cancellation rights at or before loan closings. As a result, most consumers need to educate themselves. Ask your lender to explain when and under what circumstances you could terminate premium payments.
* Don't expect lenders to notify you when you qualify for cancellation. You've got to make that request, in writing.
* Even if your lender maintains a general policy of "no cancellation" of mortgage insurance, your situation may be compelling and worth an exception. What if you get nowhere with a reasonable request? In a low-interest rate environment, you always have the right to pull the plug by refinancing.